The choices you make today can help preserve your hard-earned assets for tomorrow. If you have retirement funds that you're not currently using for living expenses, and want to maximize their value for the next generation, legacy protection may be the answer.
How Legacy Protection Works
Not all assets are taxed the same way. Some are great vehicles for accumulating wealth, but others — like legacy protection — are better for passing wealth to your beneficiaries.
The name says it all — 'legacy protection' involves protecting one's legacy by attempting to manage the tax liability incurred at death. When it comes to retirement, a legacy protection strategy lets you transfer retirement dollars from one of your current accounts1 to a more tax-efficient asset like a life insurance policy — which provides a generally income tax-free death benefit2.
Taxes can dramatically shrink your legacy. But a legacy protection strategy can help minimize taxation and maximize the assets you leave behind.
Is Legacy Protection for Everyone?
Legacy protection may work best for people who:
- Have reached retirement age;
- Live comfortably on other retirement income;
- Do not need additional income; and
- Have designated certain assets for family members or charities.
Legacy Protection Addresses Retirement Plan Taxes
Traditional IRAs and qualified retirement plans — 401(k)s, profit sharing plans, etc. — are very efficient accumulation vehicles for retirement. Untaxed dollars are used to fund the plan, and income taxes are deferred as long as the funds remain in the plan.
But, these retirement plans become inefficient when funds are distributed at retirement. And at death, funds in these plans may be subject to double taxation — both income and transfer taxes. If you die with money in a qualified plan, income tax may be taken out when funds are distributed to beneficiaries. Unless your beneficiary is a spouse or another eligible beneficiary, the SECURE Act effective January 1, 2020 requires distributions to be taken from IRAs and qualified plans by your beneficiaries by the end of the 10th year after your death, which could cost your beneficiary far more in taxes than under prior law when they had the option to stretch distributions – and taxes - over their lifetimes.
A Potential Solution
If you want to preserve the hard-earned assets from your traditional IRA or 401(k) to pass on to your beneficiaries, you need a strategy to help maximize their value and minimize the effects of taxation. Legacy protection strategies make preserving your assets—and your legacy—possible by turning traditional IRAs and other qualified retirement plans into an asset that is more tax-efficient—a life insurance policy that may pass generally income tax-free to your beneficiaries.
Legacy Protection Preserves Required Minimum Distributions
Income and transfer taxes are not all you should be concerned with when it comes to retirement plans: after you reach age 73, annual distributions must also be taken from traditional IRAs and most qualified retirement plans. So, whether you actually need these distributions or not, the IRS requires that you take part of the account each year anyway. This is called a required minimum distribution or RMD.
If you don't take a required minimum distribution, it means your distribution assets will be taxed again. This time a whopping 50 percent penalty tax is taken from any amount you were required to withdraw, but didn't.
So with RMDs, you may not need the money right away — but you're required to take the distribution specified by the IRS and pay current income taxes on it. If you don't take the distribution, you'll pay an even more punitive tax penalty.
A Potential Solution
There is a way to use the required minimum distribution to help maximize the inheritance you leave to beneficiaries. Legacy protection lets you place retirement funds in one of the most tax-efficient vehicles for transferring assets — a life insurance policy. By using the after-tax amount of your RMD to purchase life insurance, you help maximize your legacy and avoid transfer taxes. Properly designed and funded, life insurance passes generally tax-free to beneficiaries — helping preserve the legacy you intended for them to enjoy.
As you can see, taxes may dramatically shrink your legacy. Whether you want to leave assets to your children and grandchildren, or support your church or a charitable organization, legacy protection helps increase the legacy and can help stop the drain on your retirement assets.
